After a delay with its national accounts publications, Eurostat has now caught up. Fourth-quarter numbers are beginning to sip out, with the following press release last Friday:
Seasonally adjusted GDP rose by 0.3% in the euro area (EA18) and by 0.4% in the EU28 during the fourth quarter of 2014, compared with the previous quarter, according to flash estimates published by Eurostat, the statistical office of the European Union. In the third quarter of 2014, GDP grew by 0.2% in the euro area and by 0.3% in the EU28.
More important, though, is the annual growth rate:
Compared with the same quarter of the previous year, seasonally adjusted GDP rose by 0.9% in the euro area and by 1.3% in the EU28 in the fourth quarter of 2014, after +0.8% and +1.3% respectively in the previous quarter. During the fourth quarter of 2014, GDP in the United States increased by … 2.5% (after +2.7% in the previous quarter).
The U.S. economy is still way ahead of Europe, and there are no signs of this parity shrinking. For the three countries where Eurostat has reported individual 2014 GDP numbers, inflation-adjusted growth rates are far from impressive:
- Germany: 1.61 percent;
- France: 0.38 percent;
- Greece: 0.87 percent.
For the two largest economies in the euro zone, Germany and France, the combined growth rate is 1.08 percent. That is a minuscule uptick over the second and third quarter annual growth rates of 0.99 and 1.02 percent, respectively. Furthermore, while the combined growth rate for Germany and France is slowly increasing, the individual growth rates for the two countries are going in different directions. Again, annual inflation-adjusted growth rates reported by quarter:
Frustrating comments are already pouring out over the internet. EUbusiness.co. says that the numbers are “too weak to convincingly signal a full-blown recovery”. They are absolutely right. Analysts quoted by EUbusiness.com attribute the slight uptick in growth to falling oil prices and a weaker euro. Both of these are external factors, which means that Europe still has no core growth power. It is also important to remember that the weak euro partly is attributable to concerns about the future of the currency. With Greece basically in open defiance of payment obligations and EU-imposed austerity programs, and with countries like Portugal and Italy likely to join Greece should Athens decide to secede from the currency union, there are complicated, long-term reasons for a weak euro.
One analyst suggests to EUbusiness.com that the fact that the ECB has basically eliminated interest rates is adding so much to the picture that it is time to talk about a European recovery:
The ECB’s version of so-called quantitative easing has already decreased government borrowing prices across most of the currency bloc and weakened the euro, which should help to boost exports in Europe. “For the first time in two years, we can say that the region is going for solid growth,” Anna Maria Grimaldi, an economist at Intesa Sanpaolo SpA in Milan, told Bloomberg News. “The euro area is supported by the very strong tailwinds of the fall of the euro, the fall of oil prices and the fall of interest rates sparked by ECB QE.”
However, as I explained last week, the zeroing of interest rates has at best led to a temporary boost in business investments. There are no signs of a permanent recovery.
I will repeat this ad nauseam: unlike the American economy, the European economy has no reason to recover.
The stagnant European economy does not need more bad news. Unfortunately, there is more coming. Business Insider reports:
The amazing collapse in German bond yields is continuing. Today, five-year bonds (or bunds) have a negative nominal return for the first time ever. That means that investors buying a 5-year bond on the market today will effectively be paying the German government for the privilege of owning some of its debt. This has been happening for some time now. In 2012, people were amazed when 6-month bund yields went into negative territory. In August, the two-year yield went negative too. Less than a month ago, the same thing happened with the country’s four-year bunds.
While there is a downward trend in bond yields in most euro-zone countries, there is a clear discrepancy between first-tier and second-tier euro states. Ten-year treasury bond yields, other than Germany:
- Austria, 0.71 percent, trending firmly downward; France, 0.83 percent, trending firmly downward; Netherlands, 0.68 percent, trending firmly downward; Italy, 1.87 percent, trending firmly downward.
A couple of second-tier examples:
- Ireland, 1.24 percent, trending weakly downward; Portugal, 2.69 percent, trending weakly downward.
Greece is the real outlier at 9.59 percent and an upward yield trend. But Greece is also a reason why Germany’s bond yields are turning negative. Although the Greek economy is no longer plunging into the dungeon of depression, it is not recovering. Basically, it is in a state of stagnation. Its very high unemployment and weak growth is coupled with an ongoing austerity program, imposed by the EU, the ECB and the IMF.
Add to that the political instability which, in late January, will probably lead to a new, radically leftist government. Syriza’s ideological point of gravity is the Chavista socialism that has been practiced in Venezuela over the past 10-15 years. They are also vocal opponents to the EU-imposed austerity programs, an opposition they would have to deliver on in case they want to stay relevant in Greek politics.
If Greece unilaterally ends its austerity program, it de facto means the beginning of their secession from the euro. That in turn would raise the possibility of other secessions, such as France, where a President Le Pen would begin her term in 2017 with a plan to reintroduce the franc. When that happens, the euro is history.
There is no history of anything similar happening in modern history, which makes it very difficult for anyone, economist or not, to predict what will happen. Europe’s political leaders will, of course, want to make the transition as smooth and predictable, but without experience to draw on there is a considerable risk that the process will be neither smooth nor politically controllable. Add to that the inability of econometricians to forecast the transition; based on the numerous examples of forecasting errors from the past couple of years, there is going to be little reliable support from the forecasting community for a rollback of the euro.
That is not to say the process cannot be a success. But the window of uncertainty is so large that it alone explains the investor flight to German treasury bonds.
This uncertainty is also throwing a wet blanket over almost the entire European economy, an economy that desperately needs growth and new jobs. Since 2010 the EU-28 economy has added 800,000 new jobs, an increase of 0.37 percent. For comparison, during the same time the American economy has added eleven million jobs, an increase of a healthy 8.5 percent.
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While this year is promising for many, especially Americans who have a steadily improving job market to search for new opportunities, the outlook on the new year is hardly better in Europe today than it was a year ago. As far as Europe is concerned, 2014 went down in history as the year of squandered hopes for a recovery. I have lost track of all the forecasts that predicted “the” recovery take-off during last year, though it would be valuable for future reference to collect all the “squandered hopes” forecasts. There is a lot to be learned from the serial failures of econometrics-based forecasting during 2014.
The reason why Europe is nowhere near a recovery is that its political leadership is doing absolutely nothing to address the fundamental structural problem of their economy. The welfare state is still in place and its austerity policies have been driven by an urge to save the welfare state – make it slimmer and more affordable – so that it can fit inside a smaller economy with high unemployment and weak tax revenues. But it is precisely these efforts that have escalated the current crisis to a level where – as I explain in my book – it has now become a permanent state of economic affairs.
So long as Europe’s leaders refuse to acknowledge the nature of the economic crisis, they will continue to inject the patient with the medicine that perpetuates the illness.
There are some lights in the tunnel, for sure. The Greek economy has, of late, shown signs of transitioning from an almost unreal ratcheting down into an economic depression to a state that is at least a little bit promising. Its vital macroeconomic signs indicate stagnation rather than decline, which is hardly something to write home about, but good news for people who on average have lost 25 percent of their income, their jobs, and their standard of living since the beginning of the Great Recession.
Sadly, just as the Greeks were being given an opportunity to catch their breath, their elected officials went ahead and caused an early parliamentary election to be held in late January. If current opinion polls are correct, the next prime minister will be Mr. Tsirpas of the Syriza party – a radical socialist group that considers deceased Venezuelan president Hugo Chavez and his authoritarian government a good role model.
Greece does not need an economic model that has caused high unemployment, eradicated property rights and brought about 63 percent inflation. Greece needs major free-market reforms, thoughtfully executed and coupled with growth-generating tax cuts.
But Greece is not the only EU member state that is struggling. France is going nowhere, and going there fast. The socialists in charge in Paris stick to their tax-to-the-max policies, which is part of the reason why the country is going into 2015 with record-high unemployment. Economic forecasters, perhaps burned by last year’s irresponsibly positive predictions, now expect a 0.4-percent increase in real GDP for 2015. That is much more realistic.
Overall, when predicting Europe’s future, one should not ask “when is the economy going to recover?” but “what reasons do the European economy have to start growing again?”.
Again, there is not much positive to look forward to for our European friends. However, it is better to talk about things the way they are, and then find a solution to the problems thus identified, than to pretend that everything is really not what it really is.
Europe has a lot of potential. It could join us here in America and restore prosperity, hope and opportunity for the entire industrialized world. If Europe chooses to do so, we have a future to look forward to that is almost unimaginably positive.
If, on the other hand, Europe’s political leaders stick to their statist guns, their continent will continue on its current path to becoming the next Latin America. It will no longer be even close to comparison with the United States, whose economy will continue its ho-hum economic recovery through 2015 and 2016. Beyond that, it depends entirely on who is elected president next year. If it is a Republican friendly to Capitalism, like Rand Paul or Mitt Romney, we will know for certain that there will be good, growth-promoting tax and spending reforms. A more mainstream-oriented Jeb Bush or Chris Christie would also be good, but not only second-tier good.
Even a fiscally conservative Democrat would be preferable to the kind of leadership they have in Europe.
Hopefully, there can be some libertarian-inspired change for the better in Britain thanks to the seemingly unstoppable UKIP. Maybe – just maybe – that could inspire a surge of support for libertarian ideas elsewhere in Europe.
Since 2012 I have been predicting that Europe will transition from the downslope of the Great Recession into a state of long-term “stable stagnation” – a state best described as industrial poverty. (I define it here.) For the past 12-18 months GDP and other data have shown that the downslope is ending, and that the state of stagnation now has Europe in a firm grip. Weak signs of an economic recovery in Greece and Spain do not contradict this observation: the two countries hit the hardest by the recession are simply adjusting to the aftermath of some of the hardest austerity policies on record.
One of the characteristics of the crisis downslope was a barrage of credit downgrades of governments in EU member states – and Greece was far from alone here. Spain, Portugal and Ireland suffered five downgrades each, starting in 2009, sending Spanish treasury bonds to the financial junk yard by 2012. Italy was downgraded three times, starting in 2011, and France lost its AAA rating with Standard & Poor in January 2012. In November that year Moody’s downgraded France, followed by Fitch in July of 2013 and yet another downgrade by S&P in November last year.
Now Fitch is at it again. After having reduced France to AA+ in July last year the rating institute has now decided to kick the French down another notch. Explains Fitch:
When it placed the ratings on RWN in October, Fitch commented that it would likely downgrade the ratings by one notch in the absence of a material improvement in the trajectory of public debt dynamics following the European Commission’s (EC) opinion on France’s 2015 budget. Since that review, the government has announced additional budget saving measures of EUR3.6bn (0.17% of GDP) for 2015, which will push down next year’s official headline fiscal deficit target to 4.1% of GDP from the previous forecast of 4.3%.
The reason why Fitch focuses on the French government’s budget deficit is the prevailing notion that a big deficit is bad for the economy. In reality, the biggest threat is that a deficit will weaken or eventually destroy the ability of government to pay its obligations through welfare-state entitlements. Austerity policies in Europe have been aimed at closing deficits in order to save welfare states from pending default on entitlements: the idea has, simply speaking, been to make the welfare states more “affordable”. The affordability is measured in terms of budget balancing – a deficit is taken as a sign that the welfare state cannot support its spending obligations.
It is not entirely clear whether or not Fitch and others factor this into their ratings. The outcome, however, of their analysis is precisely that: a welfare state that is chronically unable to fund its entitlements will sooner or later be downgraded.
This is what has just happened to France. Back to the Fitch report:
The 2015 budget involves a significant slippage against prior budget deficit targets. The government now projects the general government budget deficit at 4.4% in 2014 (up from 3.8% in the April Stability Programme with the slippage led by weaker than expected growth and inflation) and 4.1% in 2015 (previously 3.0%), representing no improvement from the 4.1% of GDP achieved in 2013. It has postponed its commitment to meet the headline EU fiscal deficit threshold of at most 3% of GDP from 2015 until 2017.
And this despite enacted as well as announced increases in the tax burden on the French economy. As I noted a week ago:
In other words, no stronger growth outlook, no sustainable improvement in business investments or job creation. As a matter of fact, a closer look at the measures that Mr. Sapin refers to reveals a frail, temporary improvement that will not put France on the right side in any meaningful macroeconomic category
Even the part of the deficit that the government can reduce is largely due to a reduction in the annual EU membership fee. There is no underlying macroeconomic improvement behind the small deficit decline. With this in mind it is easy to see why the Fitch report expresses concern about the future of the French economy:
The weak outlook for the French economy impairs the prospects for fiscal consolidation and stabilising the public debt ratio. The French economy underperformed Fitch’s and the government’s expectations in 1H14 as it struggled to find any growth momentum, in common with a number of other eurozone countries. Underlying trends remained weak despite the economy growing more strongly than expected in 3Q, when inventories and public spending provided an uplift.
And, as if to top off the analysis:
Fitch’s near-term GDP growth projections are unchanged from the October review of 0.4% in 2014 and 0.8% in 2015, down from 0.7% and 1.2% previously. Continued high unemployment at 10.5% is also weighing on economic and fiscal prospects. The on-going period of weak economic performance, which started from 2012, increases the uncertainty over medium-term growth prospects. The French economy is expected to grow less than the eurozone average this year for the first time in four years.
And that is quite an achievement, given the notoriously weak growth in the euro zone.
Overall, this is yet more evidence of long-term stagnation in Europe. The bottom line: don’t ask when Europe will recover – ask what reason the European economy has to recover.
In a few articles recently I have pointed to some evidence of an emerging economic recovery in Spain and Greece. This is not a return to anything like normal macroeconomic conditions, but more a stagnation at a depressed level of economic activity. To call it a “recovery” is a stretch, but given the desperate circumstances of the past few years, an end to the depression is almost like a recovery.
The transition from a depression with plunging GDP, vanishing jobs and overall an economy in tailspin, to stagnation where nothing gets neither better nor worse, is in fact a verification of my long-standing theory. Europe has entered a new era of permanent stagnation – an era best described as industrial poverty – and is slowly but steadily becoming a second-tier economy on the global stage. The path into that dull future is paved with decisions made by political leaders, both at the EU level and in national governments. While they do have the power to actually return Europe to global prosperity leadership, they choose not to use that power. Instead, their economic policies continue to destroy the opportunities for growth, prosperity and full employment.
In fact, Europe’s leaders have the opportunity on a daily basis to choose which way to go. The difference is made in their responses to the economic situation in individual EU member states. Let us look at two examples.
First out is an article from Euractiv a month ago:
Greece is “highly unlikely” to end its eurozone bailout programme without some new form of assistance that will require it to meet targets, a senior EU official said on Monday (3 November). “A completely clean exit is highly unlikely,” the official told reporters, on condition of anonymity. “We will have to explore what other options there are. Whatever options we may be adopting, it will be a contractual relationship between the euro area institutions and the Greek authorities,” the official said.
How will the EU, the European Central Bank and the International Monetary Fund respond to this? Will they continue to impose the same austerity mandates that they began forcing upon Greece four years ago? Back to Euractiv:
The eurozone and IMF bailout support of €240 billion began in May 2010. Greece is in negotiation with EU institutions and the International Monetary Fund ahead of the expiry of its bailout package with the European Union on 31 December. Athens has said it wants its bailout to finish when EU funding stops, though the IMF is scheduled to stay through to early 2016. The EU official said he expected eurozone ministers and Greece to decide on how best to help Athens at a meeting of finance ministers in Brussels on 8 December.
If the EU decides to continue with the same type of bailout program, thus continuing to demand government spending cuts and tax hikes, then their response to this particular situation will continue the economic policies that keep Europe on its current path into perpetual industrial poverty.
The second example, France, also presents Europe’s political leadership with a fork-in-the-road kind of choice. From the EU Observer:
France’s finance minister cut the country’s deficit forecast for 2015 on Wednesday (3 November) adding that Paris will be well within the EU’s 3 percent limit by 2017. Michel Sapin told a press conference that he had revised France’s expected deficit down to 4.1 percent from the 4.3 percent previously forecast, as a consequence of extra savings worth €3.6 billion announced by Sapin in October.
That sounds good, but what is the reason for this improved forecast – and, as always with optimistic outlooks in Europe, can we trust it?
The extra money does not come from additional spending cuts but instead from lower interest expenses from servicing France’s debts, a reduction in its contributions to the EU budget, and extra tax revenues from a clampdown on tax evasion and a new tax on second homes. “We have revised the 2015 deficit … without touching the fundamentals of French economic policy,” Sapin told reporters.
This also means they have done their debt revision without seeing a change for the better in “the fundamentals” of the French economy. In other words, no stronger growth outlook, no sustainable improvement in business investments or job creation. As a matter of fact, a closer look at the measures that Mr. Sapin refers to reveals a frail, temporary improvement that will not put France on the right side in any meaningful macroeconomic category:
- A lower interest rate on French government debt is almost entirely the work of the European Central Bank and its irresponsible money-printing; the French are paying lower interest rates on ten-year treasury bonds than we do here in the United States, but that will last only for as long as investors remain confident in the ECB’s version of Quantitative Easing; interest rates will quickly start rising again once that confidence is shattered – and it will be shattered as soon as investors realize that, unlike in the United States, the European economy will not start growing again;
- Reduced French EU contributions come at the expense of other countries and likely won’t last very long; as soon as other countries have grown impatient with the French, they will force Paris to increase its contributions again; besides, this “reduced EU contributions” thing is basically just an accounting trick – effectively it means that the EU has reduced their demands on how much France needs to cut its deficit to be “compliant”;
- A new second-home tax is a tax increase to which taxpayers will make the necessary adjustments; they will move from owning a home to renting one or to extended-stay vacations at luxury hotels; once that adjustment reaches a critical point the French government will have lost the new revenue and their hopes of being “compliant” with the EU deficit requirement will fade away.
If the French government spent all the political and legislative efforts that went into these measures, on structural reforms to the French government, then France would be en route to a major improvement in growth, jobs creation, business investments and the standard of living of their citizens. But that is not going to happen. All they do is try to comply with the same old statist rules that have forced them to balance their budget – and save their welfare state – instead of promoting the prosperity of their people.
There is a painful shortsightedness in European fiscal policy, one that almost entirely prevents the political leadership of that continent to look beyond the next fiscal year. It is time for them to stop, raise their eyes to the horizon and think about where they want their continent to be ten years from now.
If they don’t, I can surely say where they are going to be: in an era of industrial poverty, colored by three shades of grey, where children are destined to – at best – live a life no better than what their parents could accomplish. Think Argentina since the decline and fall of their 15 years of global economic fame.
Think Eastern Europe under Soviet rule.
Yankees baseball legend Yogi Berra coined the proverbial phrase “It ain’t over ’til it’s over”. That is certainly true about the European economic crisis. This past week saw a crop of bad news from the Old World. Nothing very dramatic – and certainly nothing that should surprise regular readers of this blog – but nevertheless bad news. In this first of two parts, let’s look at a report from the EU Observer:
The eurozone appears to have come back onto the markets’ radar amid low inflation, poor economic news from Germany, and Greece’s bailout exit plans. Greece’s long-term borrowing costs went above 8 percent on Thursday (16 October) – their highest for almost a year – as investors took fright at the fragile political situation in the country. The government in Athens has tried to shore up popular support by suggesting it will exit its bailout programme with the International Monetary fund more than a year early.
There is an important background here. The bailout program had three components:
1. The Greek government will do everything in its power to combine a balanced budget with protecting as much as possible of its welfare state against the economic depression;
2. In return for the Greek government’s tax increases and spending cuts, the International Monetary Fund, the European Union and the European Central Bank provided loans that kept the Greek government afloat cash-wise;
3. The only metric used to measure the success of bailout policies is the stability of a balanced government budget.
If GDP did not grow, if unemployment was at 30 percent, if more than half the young in Greece had no job to go to… none of that mattered. As a result, there has been no structural improvement of the Greek economy; government has not reduced its burden on the private sector – quite the contrary, in fact. Welfare systems have been reduced, but higher taxes have prevented welfare recipients from transitioning into self sufficiency.
As a result, the social situation in Greece is almost unbearable. The political reaction has come in the form of a surge for parties on the extreme flanks of the political spectrum. In my book Industrial Poverty I explain in detail what happened in Greece, what brought the country down from the heights of European prosperity to permanent stagnation. Today, sadly, the country is little more than a macroeconomic wasteland.
It is with this in mind that one should approach the news that Greece is considering leaving the bailout program. The coalition government is under enormous pressure to save the nation itself, to keep parliamentary democracy in place and to inject some sort of life into the economy. If they fail either of two extreme political movements will take over – the Chavista communists in Syriza or the Nazis in Golden Dawn.
International investors know this and are understandably scared. In their mind the bailout is the least of available evils; in reality, as I explain in my book, the attempts at balancing the budget and saving the welfare state in the midst of the crisis are the very policies that keep Greece from recovering; weak signs of a minor recovery earlier this year have yet to materialize into anything other than the “beaten dog” syndrome often following protracted periods of austertiy.
This is the very reason why Greece is now considering leaving the bailout program. They cannot continue forever to try to muddle through with an economy deadlocked in depression and a democracy so fragile that it has brought the first Nazis into a parliament in Europe for the first time since World War II.
However, as the EU Observer explains, the Greek government is caught between a rock and a hard place – as are other hard-hit euro zone economies:
But the recent announcement spooked investors, unconvinced that Greece can stand alone. Long-term borrowing costs also jumped in the weak periphery states, Spain, Italy, and Portugal. The market jitters – while not comparable to the height of the eurozone crisis in 2011 and 2012 – come as the eurozone’s main economies are once again at odds over policy responses.
France also belongs on that list, primarily for its typically European attempt at leaving the bailout program. Its government tried to leave the bailout path for a left turn into the quagmire of government expansionism. Thinking that more government spending, on top of the largest government spending in the world, could in fact bring about a recovery, the French socialists who won the 2012 elections scoffed at the EU balanced-budget rules and went full speed ahead with their government-expansionist agenda.
Two years later that agenda has hit a brick wall. Massive tax increases, supposed to pay for some of the new government spending, have only resulted in an exodus of brain power and entrepreneurship. The French GDP is standing more still than the Eiffel Tower.
In fact, the EU Observer notes,
France and Italy are fighting a rearguard action for more flexibility saying budget slashing will condemn them to further low growth. Paris is on collision course with both Berlin and the European Commission after having indicated that it wants an extra two years to bring its budget deficit to below 3 percent of GDP. Italy, meanwhile, has submitted a national budget for 2015 which brings the country to the edge of breaking the rules.
The French challenge to the budget-balance rules compounds the uncertainty emanating from the talks in Athens about a Greek bailout exit. It is more than a theoretical possibility that at least one of these countries leaves the euro zone in the next two years, and does so for a combination of political and economic reasons. That would be an institutional change to the European economy – and really the global economy – of such proportions that no traditional quantitative analysis can render justice to a forecast of its effects. It is therefore entirely logical that global investors are growing more uncertain and as a result demand higher risk premiums.
As the icing on the uncertainty cake, informed investors know that Marine Le Pen may very well become France’s next president. If she wins in 2017 her first order of business is in all likelihood going to be to exit the euro zone and reintroduce the franc. On the one hand that could be an “orderly” exit; on the other hand it would have ripple effects throughout the southern rim of the euro zone to the point where the very future of the common currency is in grave danger.
In summary: mounting uncertainty about the future of the euro is being mixed with growing uncertainty about the macroeconomic performance of the member states of the currency union.
Stay tuned for the second part about the bad news out of Europe.
I recently noted that the French government has resorted to desperate tax cuts. These cuts reflect a major change in economic thinking in Paris, but the decisiveness of this turnaround struck me as a bit odd. After all, there was no unpredictable economic news out there to explain why it happened now.
Or was there?
British newspaper Independent has the story:
The land of 400 cheeses, the birthplace of Molière and Coco Chanel, is facing an unprecedented exodus. Up to 2.5 million French people now live abroad, and more are bidding “au revoir” each year. A French parliamentary commission of inquiry is due to publish its report on emigration on Tuesday, but Le Figaro reported yesterday that because of a political dispute among its members over the reasons for the exodus, a “counter-report” by the opposition right-wing is to be released as an annex.
And why is this such a controversial topic? The Independent explains:
Centre-right deputies are convinced that the people who are the “lifeblood” of France are leaving because of “the impression that it’s impossible to succeed”, said Luc Chatel, secretary general of the UMP, who chaired the commission. There is “an anti-work mentality, absurd fiscal pressure, a lack of promotion prospects, and the burden of debt hanging over future generations,” he told Le Figaro.
That is France in a nutshell. No other country in Europe, not even Sweden, has been able to combine welfare-state entitlements with ideologically driven labor market regulations to the extent that the French have. (In Sweden, labor market law delegates the right to regulate the labor market to the unions instead, effectively elevating them to government power without government accountability.) But this is not the work of two years of socialism under President Hollande – it has been very long in the making. Alas, the Independent continues:
However, the report’s author Yann Galut, a Socialist deputy, said the UMP was unhappy because it had been unable to prove that a “massive exile” had taken place since the election of President François Hollande in 2012. What is certain is the steady rise in the number of emigrants across all sections of society, from young people looking for jobs to entrepreneurs to pensioners. According to a French Foreign Ministry report published at the end of last month, the top five destinations are the UK, Switzerland, the US, Belgium and Germany.
So here we have the explanation of why the French government is now scrambling to cut taxes. Their tax increases were the straw that broke the camel’s back. By raising the top income tax bracket to a confiscatory 75 percent they gave tens of thousands of entrepreneurs, medical doctors, computer engineers, finance experts, investors and business executives the final reason they needed to leave the country. As a result, tax revenue from the punitive taxes introduced under Hollande are nowhere near what the socialist government had planned for. As a result there is less money in government coffers to pay for the same socialist government’s entitlements.
The smaller-than-planned revenue stream in combination with larger-than-affordable entitlement spending opens up a budget deficit. The French government is already in breach of the EU balanced-budget law, often referred to as the Stability and Growth Pact. A self-inflicted escalation of the deficit puts Hollande in direct confrontation with the EU Commission, which is already loudly complaining that France seems perennially unable to bring its deficit down under the ceiling of three percent of GDP mandated by the aforementioned Pact.
Back now to the Independent for some more details on the French exodus:
Hélène Charveriat, the delegate-general of the Union of French Citizens Abroad … told The Independent that while the figure of 2.5 million expatriates is “not enormous”, what is more troubling is the increase of about 2 per cent each year. “Young people feel stuck, and they want interesting jobs. Businessmen say the labour code is complex and they’re taxed even before they start working. Pensioners can also pay less tax abroad,” she says.
Wait… what was that?
Businessmen say the labour code is complex and they’re taxed even before they start working.
Those evil capitalists. Two 20-year-old guys from working class homes have a passion for fixing people’s cars. They decide to open their own shop and start by working their way through the onerous French bureaucratic grinds to get their business permit. (I know someone who tried that. A story in and of itself. I’ll see if he wants to tell it in his own words.) Once they have the permit they scrape together whatever cash they can, buy some used tools and put down two months rent on a garage at a closed-down gas station. While they get the tools together, find the garage and get everything set up they obviously have no revenue. But that does not stop The People’s Friendly Government from showing up at their doorsteps to collect taxes on money they have not yet made.
These two young Frenchmen do not exist. And if they did, they would move to England and open their shop there instead, thus joining the growing outflow of driven, productive Frenchmen from all walks of life. But it is actually good that the Independent is less interested in reporting on the young French expatriates and instead puts focus on the country’s hate-the-rich taxes:
As for high-earners, almost 600 people subject to a wealth tax on assets of more than €800,000 (£630,000) left France in 2012, 20 per cent more than the previous year.
Governments in high-tax countries rarely pay any attention to the outflow of their young, productive and aspiring citizens. The argument is that those young people don’t pay much taxes anyway. Right now. Of course, if they are allowed to work and build careers and businesses instead of emigrating, they will become wealthy and create lots of jobs in the future. That, however, is a perspective that big-government proponents notoriously overlook. Therefore, there is really just one way to explain to them what harm their punitive tax policies do, and that is to shed light on the exodus of wealthy, productive people happening right now. Such news can actually work.
As indicated by my earlier article on the desperate French tax cuts, it may already be working. The French government cannot ignore forever how its combination of a wealth tax and a 75-percent tax on top incomes destroy existing jobs and, more importantly, solidly and decisively prevents the creation of new ones. They cannot forever dwell in the delusion that government somehow can raise GDP growth above the current level of zero percent, and they certainly cannot use government to create jobs for the more than ten percent of the work force that are currently unemployed.
It remains to be seen how sincere the French socialist government is about reversing course. It is by no means certain that the newly announced tax cuts mark a turning point. It could just as well be that they are mere token gestures, aimed at giving false hope of a better future to new prospective emigrants.
Almost everywhere you look in Europe there is unrelenting support for a continuation of policies that preserve big government. Hell-bent on saving their welfare state, the leaders of both the EU and the member states stubbornly push for either more government-saving austerity or more government-saving spending. In both cases the end result is the same: fiscal policy puts government above the private sector and leads the entire continent into industrial poverty.
Monetary policy is also designed for the same purpose, which has now placed Europe in the liquidity trap and a potentially lethal deflation spiral. The European Central Bank is fearful of a future with declining prices, thus pumping out new money supply to somehow re-ignite inflation. In doing so they are copying a tried-and-failed Japanese strategy, on which Forbes magazine commented in April after news came out that prices had turned a corner in the Land of the Rising Sun:
Japan’s government and central bank are likely to get much more inflation than they bargained for. This risks a sharp spike in interest rates and a bond market rout, with investors fleeing amid concerns about the government’s ability to repay its enormous debt load. In the ultimate irony, it may not be the deflationary bogey man which finally kills the Japanese economy. Rather, it could be the inflation so beloved by central bankers and economists that does it.
This is a good point. Monetary inflation is an entirely different phenomenon than real-sector inflation. The latter is anchored in actual economic activity, i.e., production, consumption, trade and investment. It emerges because basic, universally understood free-market mechanisms go to work: demand is bigger than supply. This classic situation keeps inflation under control because prices will only rise so long as producers and sellers can turn a profit; if they raise prices too much they attract new supply and profit margins shrink or vanish.
Monetary inflation is a different phenomenon, based not in real-sector activity but in artificially created spending power. I am not going to go into detail on how that works; for an elaborate explanation of monetary inflation, please see my articles on Venezuela. However, it is important to remember what kind of inflation European central bankers seem to be dreaming of. As they see it, monetary inflation is the last line of defense against a deflation death spiral, regardless of what is happening in Japan.
They may be right. Again, there is almost unanimous support among Europe’s political elite that whatever policies they choose, the overarching goal is to preserve the welfare state. However, there is a very remote chance that something is about to happen on that front. And it is coming from an unlikely corner of the continent – consider this story from France, reported by the EU Observer:
France has put itself on a collision course with its EU partners after rejecting calls for it to adopt further austerity measures to bring its budget deficit in line with EU rules. Outlining plans for 2015 on Wednesday (1 October), President Francois Hollande’s government said that “no further effort will be demanded of the French, because the government — while taking the fiscal responsibility needed to put the country on the right track — rejects austerity.” The budget sets out a programme of spending cuts worth €50 billion over the next three years, but will result in France not hitting the EU’s target of a budget deficit of 3 percent or less until 2017, four years later than initially forecast.
In the beginning, Holland stuck to his socialist guns, trying to grow government spending and raise taxes. However, he soon changed his mind and combined tax hikes with cuts in government spending, as per demands from the EU Commission. Now he is taking yet another step away from established fiscal policy norms by combining spending cuts, albeit limited ones, with tax cuts – yes, tax cuts:
The savings will offset tax cuts for businesses worth €40 billion in a bid to incentivise firms to hire more workers and reduce the unemployment rate. In a statement on Wednesday, finance minister Michel Sapin said the government had decided to “adapt the pace of deficit reduction to the economic situation of the country.”
The “adaptation” rhetoric is the same as the French socialists had when they took office two years ago. What has changed is the purpose: back then their fiscal strategy was entirely to grow government – because according to socialist doctrine government and only government can get anything done in this world. Now they are actually a bit concerned with the economic conditions of the private sector.
This goes to show how desperate Europe’s policy makers are becoming. In the French case it is entirely possible that Hollande is willing to become a born-again capitalist in order to keep Marine Le Pen out of the Elysee Palace. After all, the next presidential election is only three years out. But it really does not matter what Hollande’s motives are, so long as he gets his fiscal policy right.
The EU Observer again:
Last year, France was given a two-year extension by the European Commission to bring its deficit in line by 2015, but abandoned the target earlier this summer. It now forecasts that its deficit will be 4.3 percent next year. The country’s debt pile has also risen to 95 percent of GDP, well above the 60 percent limit set out in the EU’s stability and growth pact. Meanwhile, Paris has revised down its growth forecast from 1 percent to 0.4 percent over the whole of 2014, and cut its projection for 2015 to 1 percent from 1.7 percent. It does not expect to reach a 2 percent growth rate until 2019.
This is serious stuff but hardly surprising. I predict this perennial stagnation in my new book Industrial Poverty. And, as I point out in my book, a growth rate at two percent per year only keeps people’s standard of living from declining- it maintains a state of economic stagnation. There will be no new jobs created, welfare rolls won’t shrink and standard of living will not improve. For that it takes a lot more than two percent GDP growth per year.
Hollande’s new openness to – albeit minuscule – tax cuts should be viewed against the backdrop of this very serious outlook. He will probably not succeed, as the tax cuts are so small compared to the total tax burden, and the tax-cut package is not combined with labor-market deregulation. But the mere fact that he is willing to try this shows that there is at least a faint glimpse of hope for a thought revolution among Europe’s political leaders. Maybe, just maybe, they may come around and realize that their welfare statism is taking them deeper and deeper into eternal industrial poverty.
Europe keeps struggling with its impossible balanced-budget endeavor.
In a desperate attempt to save the welfare state while also balancing the government budget they keep destroying economic opportunity for their entrepreneurs and households. This leads to panic-driven spending cuts combined with higher taxes, the worst alternative of all routes available to a balanced budget. The reason – and I keep emphasizing this ad nauseam – is that they desperately do not want to remove the deficit-driving spending programs.
To break out of the shackles of their self-imposed welfare-statist version of austerity, some European politicians have suggested that the EU needs to revise the rules under which member states are brought into compliance with the Union’s balanced-budget amendment. This is not viewed kindly among the Eurocrats in Brussels. From Euractiv:
The European Commission will not let EU budget discipline rules be flouted, incoming economic affairs commissioner Pierre Moscovici said on Monday (29 September), days after his former colleagues in the French government said Paris would again miss EU targets. Last year, European Union finance ministers gave Paris an extra two years to bring its budget deficit below the EU ceiling of 3% of national output after France missed a 2013 deadline in what is called the ‘excessive deficit procedure’. But earlier this month, the French government said it would not meet the new 2015 deadline either and instead would reduce its budget shortfall below 3% only in 2017.
They certainly could meet the deadline, and they could do it even faster than proposed. All they would need to do would be to chainsaw the entire government budget until what is left fits within the three-percent rule. However, they know they cannot do that, for two reasons. The first is simple macroeconomics: so long as you do not cut taxes, any spending cuts will mean government takes more from the private sector and, relatively speaking, gives less back. That reduces private-sector activity and thus exacerbates the recession.
The second reason is that when half or more of the population depend on government for survival, you can only do so many spending cuts before they set the country on fire. The solution is a predictable way out of dependency, one that gives people an opportunity to become self sufficient without suffering undue, immediate financial hardship. That excludes tax hikes and sudden spending cuts – but on the other hand it mandates structural spending cuts that permanently terminate entitlement programs.
However, this solution to their unending economic crisis keeps eluding Europe’s policy makers.
Europe’s political leaders are getting increasingly desperate, especially since the European Central Bank’s aggressively expansionary monetary policy is proving ineffective. The more money the ECB prints, the worse the euro-zone economy performs.
The desperation is now at such a level that even the president of the ECB, Mario Draghi, is calling for EU governments to start big spending programs. Writes Benjamin Fox at EU Observer:
The European Central Bank (ECB) is preparing to step up its attempts to breathe life into the eurozone’s stagnant economy. During a speech in the US on Friday (22 August), ECB chief Mario Draghi called on eurozone treasuries to take fresh steps to stimulate demand amid signs that the bloc’s tepid recovery is stalling. “It may be useful to have a discussion on the overall fiscal stance of the euro area,” Draghi told delegates at a meeting of financiers in Jackson Hole, Wyoming, adding that governments should shift towards “a more growth-friendly overall fiscal stance.” “The risks of ‘doing too little’…outweigh those of ‘doing too much’”, he added.
Some trivia first. If you want to be rich, you have a condo on Manhattan. If you actually are rich, you have an oceanfront property in West Palm Beach. If you are genuinely wealthy you have a second home in Jackson Hole. The only people who live in Jackson Hole permanently are dyed-in-the-wool Wyomingites like former Vice President Dick Cheney (a very nice man whom I have had the honor of meeting a couple of times). It is a cold place with short, mildly warm summers and long, unforgiving winters. It is also breathtakingly beautiful.
Now for the real story… There is no doubt that Draghi is beyond worried. He should be: his monetary policy is useless. Europe is in the liquidity trap, and the European Central Bank’s expansionist monetary policy is part of the reason for this. For almost a year now Draghi has pushed the ECB to arrogantly violate the principles upon which the Bank was founded. He has printed money at a pace that by comparison almost makes Ben Bernanke look like a monetarist scrooge. More importantly, the ECB has de facto bailed out euro-zone countries even though that is very much against the statutes upon which the bank was founded. They have pushed interest rates through the floor, punishing banks for overnight lending to the bank, and they have a formal Quantitative Easing program in their back pocket.
Furthermore, the ECB was an active party in the austerity programs designed to save Europe’s welfare states in the midst of the crisis. Those programs exacerbated the crisis by suppressing activity in the private sector in order to make the welfare states look fiscally sustainable. Now Draghi is asking the same governments that he helped bully into austerity to stop trying to save their welfare states and instead be concerned with GDP growth.
Superficially this sounds like an opening toward a fiscal policy that uses private-sector metrics to measure its success. However, it is highly doubtful that Draghi and, especially, the governments of the EU’s member states, would be ready to actually do what is needed to get the European economy growing again. The first part of such a strategy would be to a combination of tax cuts and reforms to reduce and eventually eliminate the massive, redistributive entitlement programs that constitute Europe’s welfare states.
The second thing needed is a monetary policy that does not provide those same welfare states with a large supply of liquidity. The more cheap money welfare states have access to, the less inclined their governments are going to be to want to reform away their entitlement programs. On the contrary, they are going to want to preserve those programs as best they can.
Therefore, the last thing the ECB wants to do right now is to launch a QE program. Which, as the EU Observer story reports, is exactly what the ECB has in mind:
The Frankfurt-based bank is preparing to belatedly follow the lead of the US Federal Reserve and the Bank of England by launching its own programme of quantitative easing (QE) – creating money to buy financial assets.
This comes on the heels of the Bank’s new policy to increase credit supply to commercial banks on the condition that they in turn increase lending to non-financial corporations. The bizarre part of this is that in an economy that is stagnant at best, contracting at worst, there is no demand for more credit among non-financial corporations. It really does not matter if banks throw money after manufacturers, trucking companies, real estate developers… they are not going to expand their businesses unless there is someone there to buy their goods and services. If there is no buyer out there, why waste time and money on producing the product – and why take on debt to do it?
I have reported in numerous articles recently on how the European economy is not going anywhere. Growth is anemic with a negative outlook. Unemployment is stuck at almost twice the U.S. level and the overall fiscal situation of EU member states has not improved one iota despite more than three years of harsh, welfare-state saving austerity.
As yet more evidence of a stagnant Europe, Eurostat’s flash inflation estimate for August says prices increased by 0.3 percent on an annual basis. This is a further weakening of inflation and reinforces my point that unless the European economy starts moving again, it will find itself in actual deflation very soon. But the macroeconomic consequences of deflation set in earlier than formal deflation, as economic agents build it into their expectations. It looks very much as if that has now happened.
Deflation is dangerous, but it is not a problem in itself. It is a very serious symptom of an economy in depression. It is important to follow the causal chain backward and understand how the macroeconomic system brings about deflation. This blog provides that analysis; very few others attempt to do so. Ambrose Evans-Pritchard over at the good British newspaper Guardian has demonstrated good insight, and a recent article by David Brady and Michael Spence of the Hoover Institution provided some very important perspectives. But so far insights about the systemic nature of the crisis are not very widely spread.
The only advice being dispensed with some consistency is, as mentioned, the one about more government spending. Dan Steinbock of the India, China and America Institute is an example of the growing choir behind that idea. He does so, however, in a somewhat convoluted fashion. In an opinion piece for the EU Observer he discusses the macroeconomic differences between Europe and America, though in a fashion that almost makes you believe he is a regular reader of this blog:
Half a decade after the financial crisis, the United States is recovering, but Europe is suffering a lost decade. Why? In the second quarter, the US economy grew at a seasonally adjusted annual rate of 4 percent, surpassing expectations. In the same time period, economic growth in the eurozone slowed to a halt (0.2%), well before the impact of the sanctions imposed on and by Russia over Ukraine. Germany’s economy contracted (-0.6%). France’s continued to stagnate (-0.1%) and Italy’s took a dive (-0.8%). How did this new status quo come about?
He is correct about the American economy widening its gap vs. Europe, he is correct about the Italian economy, about the French economy, and about the stagnant nature of the euro-zone economy. What he does not get right is his answer to the question why the European economy has once again ground to a halt:
[In] the eurozone, real GDP growth contracted last year and shrank in the ongoing second quarter, while inflation plunged to a 4.5 year low. Europe’s core economies performed dismally. In Germany, foreign trade and investment were the weak spots. The country could still achieve close to 2 percent growth in 2014-2016 until growth is likely to decelerate to 1.5 percent by late decade. In France, President Francois Hollande has already pledged €30 billion in tax breaks and hopes to cut public spending by €50 billion by 2017. Nevertheless, French growth stayed in 0.1-0.2 percent in the 1st quarter.
Then Steinbock proceeds to make a brave attempt to explain the depth of the European economic crisis:
Fiscal austerity and falling consumer confidence are preventing domestic demand from rebounding, while investment and jobs linger in the private sector. Pierre Gattaz, head of the largest employers union in France, has called the economic situation “catastrophic.” As France is at a standstill, Paris has all but scrapped the target to shrink its deficit. … The new stance is to avoid an explicit confrontation with Germany, but to redefine austerity vis-à-vis budgetary reforms.
It is unclear what Steinbock means by this. He appears to miss the point that there are two kinds of austerity: that which aims to save government and that which aims to grow the private sector. The two are mutually exclusive, both in theory and in practice. One might suspect that Steinbock refers to the government-first version, since that is the prevailing version in Europe. However, that makes it even more unclear what Steinbock has in mind when he talks about “budgetary reforms” – an educated guess would be the relaxation of the Stability and Growth Pact so that the French government, among others, can spend more frivolously.
Such a relaxation would not contribute anything for the better. All it would do is open for more government spending. Steinbock does not make entirely clear whether or not he recommends more government spending. His article, however, seems to lean in favor of that, and I strongly disagree with him on that point for reasons I have explained on many occasions. Let’s just summarize by noting that if Europe is going to replace government-first austerity with government-first spending, then it opens up an entirely new dimension of the continent’s crisis. That dimension is in itself so ominous it requires its own detailed analysis.